Ask Liz Weston

Get smart with your money

Taxes

Q&A: Approaching retirement? Don’t count on rules of thumb

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Dear Liz: I have a few questions about my income taxes during my upcoming retirement. I would like to know if doing a Roth IRA conversion will be worth it for me since I might be in a higher tax bracket when I retire. Is there a rule of thumb in regards to doing this conversion? I’m also getting considerable income from my tax-free municipal bond and money market fund. Will that income be taxable when I retire and will it count toward how the government calculates my Medicare premiums?

Answer: Rules of thumb can be incredibly helpful in many areas of personal finance. Guidelines such as “spend less than you earn” and “pay yourself first” apply to virtually everyone. Even more specific recommendations, such as the 50/30/20 budget, can apply to many if not most situations. (The 50/30/20 budget recommends limiting “must have” expenses to 50% of after-tax income, leaving 30% for wants and 20% for savings and extra debt repayment.)

As you enter retirement, though, you’ll be making decisions that may be irreversible. It can be much harder to rebound from mistakes and you’ll have fewer years to do so. That’s why it’s important to get individualized advice from pros you can trust.

Converting a regular retirement account to a Roth IRA can make sense if you expect to be in a higher tax bracket in retirement and can pay the taxes on the conversion without raiding the account. But the conversion also can trigger higher Medicare premiums.

The same is true for municipal bond interest. Muni bond interest typically avoids income tax, but will be included in Medicare premium calculations and may cause more of your Social Security benefit to be taxable as well.

A tax pro can advise you about these issues and offer strategies to lower your lifetime tax bills.

Q&A: Filing a tax return after a parent dies

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Dear Liz: My mother’s only income was Social Security. Her accountant told her many years prior to her passing that she didn’t need to file a tax return. I was the executor of her trust and told the attorney I hired to help settle the estate that I would file her final tax return. I never did. That was 10 years ago. Now I feel that I should have filed it back then and am wondering if I should do it now or forget about it.

Answer: If you still have access to her paperwork, you can review her bank statements to see if there is any indication her income climbed enough in her last years to require filing an income tax return. If so, you can consult a tax pro about next steps.

But you’re probably fine, says estate planning attorney Jennifer Sawday in Long Beach.

If your mother was under the threshold for filing an income tax return, there would have been no reason to file a final return after she died, Sawday says.

Q&A: Don’t need your RMD? Consider a QCD

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Dear Liz: When you’re writing about required minimum distributions from retirement accounts, please make sure people know about qualified charitable distributions. Those of us lucky enough not to need the money can donate it directly from an IRA to the nonprofits of our choice. That way, we don’t even have it in our income column, and there are no taxes. I am looking forward to making many qualified charitable distributions to my favorite nonprofits when I turn 73.

Answer: You don’t have to wait. Qualified charitable distributions from IRAs can start as early as age 70½. The distribution limit for 2025 is $108,000 per individual. If you’re considering this option, please familiarize with the IRS rules for such distributions and consider consulting a tax pro.

Q&A: Selling a house? Don’t confuse the tax rules

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Dear Liz: We read your recent column about capital gains and home sales. Our understanding is that if you sell and then buy a property of equal or greater value within the 180-day window, the basis for tax purposes is the purchase price, plus the $500,000 exemption, plus the improvements to the property, minus the depreciation, whatever that number comes to, and then the profit above that has to be reinvested or it is subject to capital gains. We talked to our CPA about this and he referred us to a site that specializes in 1031 exchanges.

Answer: You’ve mashed together two different sets of tax laws.

Only the sale of your primary residence will qualify for the home sale exemption, which for a married couple can exempt as much as $500,000 of home sale profits from taxation. You must have owned and lived in the home at least two of the previous five years.

Meanwhile, 1031 exchanges allow you to defer capital gains on investment property, such as commercial or rental real estate, as long as you purchase a similar property within 180 days (and follow a bunch of other rules). The replacement property doesn’t have to be more expensive, but if it’s less expensive or has a smaller mortgage than the property you sell, you could owe capital gains taxes on the difference.

It is possible to use both tax laws on the same property, but not simultaneously.

In the past, you could do a 1031 exchange and then convert the rental property into a primary residence to claim the home sale exemption after two years. Current tax law requires waiting at least five years after a 1031 exchange before a home sale exemption can be taken.

You can turn your primary residence into a rental and after two years do a 1031 exchange, but you would be deferring capital gains, while the home sale exemption allows you to avoid them on up to $500,000 of home sale profits.

Q&A: Maxing out retirement contributions? Beware of future tax issues

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Dear Liz: I work for a local government and am trying to decide when to retire. I will receive a pension and have put away as much money as I could afford in my 457 deferred compensation plan. I invested it in a Standard & Poor’s 500 index fund that has performed well and is now worth $1.3 million. I also have a non-sheltered brokerage account of seven figures and no debt. Last year, I contributed vacation time and money to maximize my 457 contribution of $46,000. This year (and next unless I retire), I am likewise maximizing my contribution and contributing $46,000 each year. But periodically our monthly expenditures have exceeded my monthly income after the contribution and I have had to dip into the brokerage account to make up the difference. Does that make financial sense to do if needed or should I consider scaling back my contribution?

Answer: When you’re behind on saving for retirement, maximizing your contributions to tax-deferred plans in your final working years can be a smart move.

You, however, have a large amount of savings as well as a pension, so you may face a different problem: higher future taxes. Diligent savers can find themselves pushed into a higher tax bracket when required minimum distributions (RMDs) kick in. RMDs used to begin at age 70-½, but now start at age 73 for those born between 1951 through 1959 and will rise to 75 for those born in 1960 and later.

Many people with large tax-deferred retirement accounts can reduce their lifetime tax bills by converting at least some of the funds to a Roth IRA. Conversions are taxable, but Roths don’t have required minimum distributions and future withdrawals from Roths can be tax free. Conversions can affect other aspects of your retirement, such as Medicare premiums, so you’ll want sound tax advice before moving forward. You also may want to consult a fee-only financial planner who can review your overall financial situation and help you shape your retirement income plan.

Q&A: Time to move, but what about the capital gains?

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Dear Liz: My husband and I built a home on a hillside over 30 years ago in a desirable neighborhood with a beautiful view. We thought it would be our retirement home, but life had different plans. Now seniors, dealing with age, stairs and progressive health issues, we have been advised that selling and moving to a senior assisted living facility is the best option for us before we are forced by circumstances to move. And, we were told, it would be less expensive than having full-time, in-home care.

We are concerned that capital gains would take a big chunk out of the sales proceeds from our home, and that’s money we need to pay for assisted living. Can we use the purchase price of the vacant lot against the capital gains? Can we use the bank loan for building the house against the capital gains? Can we use the cost of an apartment or condo in an assisted living residence against the capital gains? What other things can be used against capital gains other than general home improvements?

Answer: A large gain wouldn’t just reduce the amount of money you have for the next phase of your life. It also could increase your Medicare premiums for a year, thanks to the income-related adjustment amount or IRMAA.

You’ll determine your potentially taxable capital gains by deducting your tax basis from your home sales proceeds. Your basis includes the purchase price of the lot and the cost of construction, plus any qualifying home improvements you’ve made over the years.

The two of you can shelter up to $500,000 of home sales profits from capital gains taxes. Capital gains also can be reduced if you have capital losses — in other words, if you’ve sold stocks or other assets for a loss.

What you do with money doesn’t affect the capital gains taxes you pay. Decades ago, you could defer capital gains by buying another home of equal or greater value, but that’s no longer the case.

You may have some alternatives to lessen the impact of the gains, such as an installment sale where the buyer pays over time. Another option would be renting out rather than selling your home.

A tax pro can provide guidance.